Markets, like any one of us, don’t take bad news well. Recently, the promoters of VRL Logistics announced plans of entering the civil aviation sector. While this foray would be routed through a separate company, the promoters could possibly sell their stake in the listed company to fund their venture. VRL’s stock fell 20%, on the back of these fears. Rewind to a few months earlier, in March 2016, when the promoters of Page Industries sold a small part of their stake in the company. Reacting to the news, Page’s stock price fell 10% as investors feared this lowering of stake might affect Page’s licensing arrangement with Jockey (USA).
Promoters selling a part of their stakes to fund their personal dreams isn’t new. Business Standard estimated that in the past two and a half months, promoters of various companies have sold equity shares worth nearly Rs 5,601crores. But when these stake sales and diversifications start impacting shareholder returns, investors should take notice. What then to make of such actions? Here are a few pointers:
1. Is the company still majority-held by the promoter? Markets take comfort from large (ideally more than 50%) stake-holdings, held by promoters. In the case of Page, promoter shareholding fell to just under 50%, which resulted in some concerns over Page’s arrangement with Jockey. In the case of companies like Eicher Motors, the stake sale was too small to really matter. As long as the promoter is focused on his company and the company’s wellbeing remains the biggest source of his wealth, a small stake sale shouldn’t really matter.
2. What is the intent of the promoter? This is a more difficult one to call. In the case of VRL Logistics, investors feared that promoters had taken their focus off their core logistics business and, instead, were foraying into aviation – a highly competitive and new business for the promoters compared to their long-standing strength in logistics. Only time will tell if these concerns were justified. However, it is difficult for any investor to read the mind of promoters or predict their behavior. This is a key risk for investors.
3. Is diversification really bad? This is a tricky one. Core competence is a key strength but when companies decide to diversify, the result of such diversification is seen much later. ITC has successfully diversified from cigarettes to FMCG but this has taken time. Reliance Industries has spent huge amounts on its telecom launch, the fate of which will be seen in the next few years. Hence, not all diversification is bad. Watch out for the execution and the way in which the promoter funds the diversification. If the new business doesn’t breakeven soon or eats up too much cash for too little profits, watch out for how promoters stay the course or cut their losses.
4. How are minorities being treated? Minorities are those non-promoter shareholders that have a large stake in a listed company. When promoters use a publicly listed company for personal gains, it raises corporate governance issues. Some examples include – setting up a separate company for new business outside of the listed company (Suzuki’s decision to set up a new plant in Gujarat, instead of routing it through Maruti), having multiple subsidiary companies with complex holding structures for no ostensible reason other than routing dodgy transactions, etc. Any promoter resorting to these tricks too often, should be watched out for.
A long-term investment in a company is a vote of faith in the promoter. However, there is no explicit guarantee that a promoter will treat minorities well. And yet, fairness to minorities, transparency in dealings, and high standards of corporate governance go a long way in increasing investor confidence in a promoter. Hence, investors should gauge promoter intent over action and analyze the promoter’s track record in dealing with minorities. Markets may not be efficient but a promoter with a bad track record of corporate governance gets punished, eventually.
Anupam Gupta is a Chartered Accountant and has worked in equity research since 2000, first as an analyst and now as a consultant. He contributes to the Business Standard platform, Punditry, through his blog, Beyond Markets on markets & the economic horizons.
He tweets as @b50
